Price and quality competition while envisioning a quality-related product recall

Many product recalls are caused by quality-related product failures. When such recalls occur, the effects may not only be limited to the firm selling the product but also extend to competing firms in the category. This paper analyzes quality and pricing strategies for competing firms facing the risk of a severe quality-related recall making the product hazardous and leading to its removal from the market. We develop a two-stage Nash game where the probability of recall depends on the firms' chosen quality investments, and either firm can experience a recall. We consider a utility-based model where consumers' sensitivity to price and quality can change following the recall. Our results indicate that the competitor should lower its price after a recall if consumers' price sensitivity changes enough and may increase or keep its price the same otherwise. Surprisingly, considering the risk of a recall does not always lead firms to enhance their product quality. If the change in consumer quality sensitivity is low enough, firms adopt an inferior product quality level than when they overlook the product recall risk, even if consumer quality sensitivity increases and/or consumer price sensitivity decreases after the recall. These results can help companies plan their pricing and quality decisions in competitive industries with potential product quality failures leading to recalls.